What goes up must come down is a saying with which we are all acquainted.
Perhaps it is not strictly true in some cases but it certainly applies
to the present state of the stock market, even as the Dow reached 10
000. But numbers and trends have nothing to do with it; they are merely
signs, symbols, things which tell us nothing in themselves. What we
need to know is whether the stock market is booming for the right reasons.
There are two kinds of booms: There is the monetary boom. This is caused
by governments using credit expansion to stimulate the economy. Its
symptoms are pretty straight forward: rising current account deficits,
falling saving rates, increasing debt ratios, accumulating malinvestments,
rising mergers, a booming stock market marked in its later stages by
reckless speculation and grossly overvalued shares.* In reality, this
is a phony boom. It is more like drug-taking except in this case the
drug is not cocaine, for example, but credit expansion.

The second kind of boom is the real McCoy. No economic steroids here.
No 'drug' dealing banks issuing addictive doses of artificial credit.
So what fuels and drives this kind of boom? The answer is savings and
entrepreneurship. America, fortunately, has no lack of the latter but
little if any of the former. In the free market, rising savings (the
transfer of purchasing power from consumption to the production of capital
goods) extends the capital structure, raises productivity and lowers
costs and prices. This is a progressive economy, one in which aggregate
profits exceeds aggregate losses. Because the profits are genuine entrepreneurial
gains and not the product of inflated credit stock market evaluations
will strongly correspond to genuine anticipated earnings streams and
thus price earnings ratios will be largely in keeping with market reality.
There will be no stock market mania; no speculative frenzy and no stratospheric
PEs.

Radio Corporation of America is an excellent example of what I mean.
In 1921 its stock stood at $US3. On the eve of the 1929 stock market
crash they had rocketed to $US573, a 6 378 per cent increase. Remember,
this was considered hi-tech stock, just like net stocks today. For about
20 years after the crash, RCA shares rarely rose above $US10, which
means that by 1950 they were still at about the 1921 price of $US3.
Needless to say, a lot of people were utterly ruined by this completely
predictable collapse. I say predictable because despite the soothing
words of Professor Irving Fisher, the likes of Dr Benjamin M. Anderson
Jr, who was chief economist at the Chase Manhattan Bank and editor of
the Chase Economic Bulletin, thought otherwise. Anderson publicly
warned that credit was too loose, that it was fuelling the stock market
boom and that a recession and severe market correction was unavoidable.
(Anderson's qualitative approach to the economy turned out to be vastly
superior to Fisher's mathematical approach). I do not doubt for a moment
that the US is in a similar situation today. From early March 1998 to
this March M1 rose by about 1.5 per cent but broad money jumped by nearly
11 per cent. This is not my idea of a steady or responsible monetary
policy.

Now let us get down to a few contemporary facts. A very important indicator
and one that is largely ignored is manufacturing. Despite the recent
rise in new jobs manufacturing contracted again, even though credit
expansion has continued. I consider this to be a very ominous sign.
Moreover, reckless lending by banks has left them dangerously exposed.
So with manufacturing contracting where are these jobs coming from?
They are mainly at the consumption end of the economy. When manufacturing
continues to contract it is not long before those producing at the consumption
stages of the economy feel the impact.

I have been asked whether the fall in bond prices which corresponds
to a 1 per cent interest rate rise indicates Fed tightening. Financial
aggregates certainly do not support the view that monetary tightening
is occurring. As I have pointed out before, credit inflation eventually
triggers real economic forces that impose a correction on the economy
even in the absence of a credit crunch. I suggest that this is happening
now. I think there are two reasons why this has not revealed itself
in the stock market indexes: 1. There is always a time lag before share
prices respond to changes in output. 2. The indexes are not representative
of American industry. In other words, a number of shares might already
be indicating a slowdown but this is being concealed by the manner in
which the indexes are constructed.

As for the title of this article, yes, I do believe the end I near.
Some think it will be early next year. However, if manufacturing contraction
is as large as I have been led to believe then I think the boom will
end this year. But don't ask me for the date until after the crash.

* I should make it clear that because a country runs a current account
deficit that in itself does not mean it is pursuing inflationary policies.
Furthermore, there is no strict relationship between money supply and
stock prices. If profit margins have been eliminated by depression and
expectations for future profits are very poor or non-existent I would
not expect a monetary expansion to raise share prices.

This piece originally appeared in The
New Australian and is reprinted with the kind permission of the
author.